What Is Strategy?

“Competitive strategy is about being different.”
—Michael E. Porter

“What is Strategy?” is a paper that Michael E. Porter published on HRB back in 1996 in an attempt to clarify the definition of strategy, which had been blurred by Japanese companies’ disruptive innovation in operational efficiency that had reshaped the competitive landscape in the US market during the 80s. So… What exactly is strategy according to Porter? Long story short: differentiation, trade-off, and fit.

Strategy is creating a unique and valuable position supported by a set of activities different from rivals’, where position is defined as the image or identity that customers have in mind for a particular product, service, brand, or organization. According to Porter, there are three origins of strategic positions:

Variety-based: Serving a wide array of customers in an industry but focusing on only a subset of their needs.

Need-based: Serving only a particular group of customers in an industry but providing products/services to meet most or all their needs.

Access-based: Serving customers that are reachable only through a different set of activities.

There is actually an array of variety- and needs-based companies that I can think of in the online advertising industry due to its fragmented competitive landscape. Criteo, for example, is a fast-growing startup that has achieved a highly successful variety-based position by focusing specifically on retargeting for display advertising. Criteo’s clients span across a wide range of advertisers globally but the company’s strategic position allows it to sharply focus on investing and building the most advanced retargeting technologies in the industry, a competitive advantage that is very difficult to match by other more generic ad networks such as Advertising.com.

iPromote, on the other hand, is a small ad agency that focuses on SMBs that are mostly looking for local advertising with limited budgets. iPromote’s needs-based position allows the company to focus on serving a very specific segment of online advertisers and customize its offerings to meet all the advertising needs from this customer group. Access-based positioning is less common in advertising online due to the “connected” nature of the digital world today but I would also consider iPromote an example of access-based positioning because reaching SMB advertisers require specialized sales activities that are fundamentally different from selling to Fortune 500.

Positioning is not about craving out a niche and the focus can be either broad or narrow. Narrowly focused positions usually thrive on groups of customers who are either over-served or under-served by the companies with relatively broader positions. Additionally, positioning is always a function of differences on supply (i.e. activities) but not necessarily on demand (i.e. customers). Two companies can serve the same need with two different positions achieved by two different sets of activities. Both Criteo and Advertising.com serve the same customers (online advertisers) but are positioning themselves very differently through two different systems of activities.

Trade-off: Strategy is choosing what not to do. Trade-offs occur when activities are incompatible and Porter gives three reasons why strategies need trade-offs:

Customers: Consistency promotes brand image & reputation. A company that tries to be all things to all customers would be delivering confusing and perhaps conflicting messages to the market.

Competitors: Inflexibility deters imitation. Different strategic positions require different sets of activities. Different sets of activities, in turn, would lead to inflexibility to switch from one position to another, thereby deterring imitators.

Trade-off is exactly how Netflix won the battle against Blockbuster. By choosing not to operate any retail store, Netflix is able to centralize its operations and significantly cut down its costs. The message to its customers is clear: largest DVD collection on earth, no late fee, and unlimited rentals. The message to its managers is clear: centralized operations, cost reduction, and market share at scale. The message to its competitors is also clear: shut off your retail stores, or never compete against us. Unable to compete against Netflix and unable to change its business model due to inflexibility, Blockbuster filed for Chapter 11 in 2010 and continues to struggle to date. Now, this is also a story that tells how the inflexibility of a strategic position can be a double-edged sword. Netflix’s inflexibility (i.e. not able to open up retail stores) protects its competitive advantages while Blockbuster’s inflexibility (i.e. not able to close its retail stores) had led it to a deadly bankruptcy.

Fit: Strategy is about designing and combing activities. There are three levels of fits:

Consistency between each activity and the strategy

Reinforcement between each activity

Optimization across activities that are consistent with the strategy and reinforcing each other

Fit cuts to the core of strategy. Porter used a simple math to explain the importance of fit, which I find extremely intriguing. Say the probability that competitors can match any activity is 90%. The probability then quickly compound to make matching the entire system (and thus the competitive advantage) extremely difficult: e.g. 0.9 * 0.9 * 0.9 * 0.9 = 0.66. Sustainable competitive advantages can then be achieved if a company performs a wide range of activities that reinforce each other, are different from its competitors, and together reflect a consistent strategic position that creates high values for its customers.

Here’s a quick mind tree that summarizes what Porter believes is a strategy:

So, what is NOT strategy? There is a clear line between strategy and operational effectiveness. Where operational effectiveness is about performing similar sets of activities in the same ways better, strategy means performing different activities (e.g. Netflix’s centralized warehouse vs. Blockbuster’s retail stores) or performing similar activities differently (e.g. Netflix’s subscription model vs. Blockbuster’s pay per rental). Without pursuing differentiation, all companies would be moving towards the productivity frontier in the same direction, thereby eroding the long-term industry profitability. While operational effectiveness and differentiation can be improved simultaneously before reaching the productivity frontier, tradeoffs are a must to achieve differentiation in the long run. This is because whereas operational effectiveness can be benchmarked and learned by all competitors over the long term, differentiation that emerges from trade-offs would be much more difficult to copy as it requires to modify the entire activity system.